US Stock Plunge? Look to Treasuries & Volatility Index

The US stock market saw a massive sell-off on Thursday, with the $DJIA(.DJI)$ and $S&P 500(.SPX)$ plunging over 1%, reflecting market panic.

This sell-off was fueled by two troubling data points: the initial jobless claims for the week of July 27 hit 249,000, higher than the expected 236,000 and previous 235,000, jumping to the highest level in a year.

Meanwhile, the US July ISM Manufacturing PMI came in at 46.8, significantly below forecasts of 48.8 and June's 48.5, marking the steepest contraction in eight months, intensifying fears of an economic recession in the US.

Tim Ghriskey, a senior portfolio strategist, noted that the ISM-driven selling is highly contagious. While the earnings season might bring some positives, any negative news like the ISM can trigger profit-taking.

Timothy R. Fiore, chair of the Institute for Supply Management, emphasized further contraction in US manufacturing activity, with weak demand, declining industries, and overall slack inputs. Firms are hesitant to invest or increase inventories due to current monetary policies and other issues, leading to declining production and adding pressure on profits.

Amid this gloomy outlook, investors can still find opportunities in Treasuries and the Volatility Index, which tend to perform well during crashes and recessions.

If the market tanks further, the $Cboe Volatility Index(VIX)$ offers good shorting opportunities. For the short-term VIX trend, if the market does not fall sharply, the market is sideways, rising, and slightly falling, the VIX index will gradually go down.

If investors believe that the subsequent market volatility will be reduced, they can short $ProShares Ultra VIX Short-Term Futures ETF(UVXY)$ by selling call options, bear market spreads and other methods. Conversely, if volatility spikes and the market tanks, go long UVXY with call options or bull spreads.

As for Treasuries $iShares 20+ Year Treasury Bond ETF(TLT)$ , the disappointing economic data has bolstered expectations of Fed rate cuts, with traders pricing in 75 basis points of easing this year. This suggests a 25 basis point cut at each of the Fed's remaining three meetings, leaving ample upside for Treasuries.

For short-term volatility in Treasuries, investors might opt for calendar spreads, which exploit differences in time value across options. By selling near-term options and buying farther-out ones, investors can profit from the faster erosion of time value in the former.

What is the calendar spread strategy?

Calendar spreads leverage the difference in time value between options with varying expiration dates to capture the spread in their time values. Options with near-term expirations lose their time value faster, while those with further-out expirations decay slower.

Investors can sell near-month contracts and buy identical far-month contracts, resulting in a positive time value gain from the former and a negative one from the latter, but the shorter-term option's time value diminishes more, generating a net positive time value income.

$iShares 20+ Year Treasury Bond ETF(TLT)$ Calendar Spread Example

A trader believes TLT will rebound significantly in the future but expects short-term market stability.

Investors can buy a call option expiring in December 24. However, due to the long time before the expiration of the option, the price of the call option will be high. Investors can sell a call option that expires in the near term to offset part of the premium.

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Step 1: Buy a call option with a strike price of $96 that expires on December 31, the premium paid is $356.

Step 2: Sell a call option with a strike price of $98 that expires on August 7, with a premium of $15.

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By August 7, if the TLT price does not rise to $98. The investor receives the premium for selling the call option. At this point, the investor still holds a long call option expiring in December and reduces the cost of going long by $15.

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Then if $iShares 20+ Year Treasury Bond ETF(TLT)$ continues to move sideways, investors can continue to sell August calls and continue to receive premium income. Investors both maintained their long positions on TLT and received premium if TLT's share price did not rise.

Investors can use this method to position short-term shocks, but long-term bullish targets. In case of misjudgment, using this strategy also controls the loss and the risk is less risky than buying the call option alone.